GLD is not the only option in gold ETFs. At least seven golden choices are available, ranging from bullion to futures, stocks and leveraged funds.
(Editor's Note: The following is an updated excerpt of an article that originally appeared in the March issue of the Exchange-Traded Funds Report. ETFR subscribers wishing to read the complete analysis can view the full piece here.)
The combination of global uncertainty and mounting inflationary pressures has exchange-traded fund investors running for gold.
The most popular gold ETF, the SPDR Gold Trust (NYSE Arca: GLD), had $31.5 billion in assets under management through Monday, making it the second-largest ETF in the world after the S&P 500 SPDR Trust (NYSE Arca: SPY), with $61.3 billion.
In fact, in the first quarter, GLD was by far the biggest attraction in ETFs. With more than $12 billion in net inflow heading into April, the fund's total topped the combined inflow of the next seven most popular ETFs. (See related story here.)
But GLD is not the only way to buy gold. Investors have at least seven golden choices in the ETF market, running the gamut from physical bullion to futures, equities and leveraged products.
The ETF an investor uses to access the gold market can have a dramatic impact on returns: For the four funds that existed for all of 2008, the range of returns ran from 5.11% to -26.08%; in December 2008 alone, the returns of the funds ranged from 1.44% to 27.51%.
Bullion: GLD And IAU
The simplest (and most popular) way to buy gold using ETFs is through one of the two bullion-backed ETFs: the aforementioned GLD or its chief competitor, the iShares COMEX Gold Trust (NYSE Arca: IAU). The two funds are substantially identical. Both hold physical gold bullion as their sole asset, literally storing gold bars in a vault. Both charge 0.40% in annual expenses, and deliver roughly identical returns. These are about as close as you can get to holding actual Krugerands or American Eagles in an exchange-traded format.
The next best thing to owning gold—and sometimes an even better thing—is to own gold futures. The PowerShares DB Gold ETF (NYSE Arca: DGL) holds a basket of gold futures contracts. Generally speaking, futures and bullion returns will be similar. But there are important differences between them to keep in mind.
The first is taxes. Bullion-based ETFs like GLD and IAU are treated as "collectibles" by the Internal Revenue Service, meaning they never qualify for long-term capital gains treatments. No matter how long you own the funds, all gains on GLD are taxed at a 28% tax rate.
DGL, in contrast, is taxed like a futures position, meaning all gains are taxed as 60% short-term gains and 40% long-term gains, no matter how long you own the fund. That creates a combined maximum tax rate of 23% for high-income individuals; for people with lower incomes, the tax rate is lower, as the 60% short-term gains are taxed at regular income tax rates.
On the downside, gains in DGL are marked-to-market at year-end, meaning investors must realize all gains in the fund each year, regardless of whether they sell or not. This complicates the tax comparison. Clearly, DGL has better short-term tax treatment than the gold bullion ETFs. It also gets a lower maximum tax rate on long-term positions. But because GLD and IAU allow you to defer taxation until you sell, they may be more favorable than DGL in certain situations.
Beyond taxes, there are two other critical factors to consider with DGL and other futures-based products. The first is contango. Contango exists when the price of an out-month futures contract—say, June gold—is more expensive than the price of a near-term contract-say, April gold. A futures-based fund like DGL must constantly sell expiring futures contracts and replace them with contracts set further out on the calendar. If those out-dated contracts are more expensive than expiring contracts, it can hurt returns. The opposite situation—when out-month contracts are cheaper than near-month contracts—can help returns; it's called backwardation.
Gold has historically traded in a small contango, meaning there has historically been a consistent but slight negative impact on returns from the process of rolling contracts forward each month. DGL uses a trading mechanism to limit the impact of contango, but over the past two years, contango has been a small drain on returns.
The contango issue is offset in part by the fact that futures-based funds must only put up a portion of their assets to buy futures, and can invest the rest of their money in fixed-income instruments, earning interest. In the case of DGL, it invests its collateral cash in 3-month Treasuries. Unfortunately, short-term Treasuries are not earning much interest these days, so this benefit is muted for now. If that situation reverses itself, DGL could become more attractive.